Aligning finance with the green transition

This paper sets out a new framework for financial policy in relation to the green transition, adapting post-war credit guidance approaches for a modern, market-based financial system.

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UCL Institute for Innovation and Public Purpose (IIPP) Working Paper Series: IIPP WP 2022/11

Authors:

• Katie Kedward | Policy Fellow, UCL Institute for Innovation for Public Purpose (IIPP)
• Daniela Gabor | Professor of Economics and Macro-finance, University of West England
• Josh Ryan-Collins | Associate Professor in Economics and Finance, UCL Institute for Innovation for Public Purpose (IIPP)

Reference:

Kedward, K., Gabor, D. and Ryan-Collins, J. (2022). Aligning finance with the green transition: From a risk-based to an allocative green credit policy regime. UCL Institute for Innovation and Public Purpose, Working Paper Series (IIPP WP 2022-11). https://www.ucl.ac.uk/bartlett/public-purpose/wp2022-11.

Abstract:

The green transition requires a substantive shift in financial flows that will not occur without policy interventions. We map out and critically assess the dominant, ‘risk-based’ approach which relies on changing the relative prices of green /dirty assets. Since it outsources the pace and nature of decarbonisation to private capital, the risk approach is poorly equipped to deal with the shift towards market-based finance, is vulnerable to arbitrage and regulatory capture, and is unable to deal with uncertainty or carbon lock-in dynamics. We propose an ‘allocative green credit policy’ regime that is organised around green industrial policy objectives and democratically agreed green missions. This draws on post-war credit policy regimes as it involves both quantitative and priced-based interventions in credit and institutional capital markets but also deals with the specific challenges posed by market-based finance. We discuss the implications of such a regime for central bank independence, inflation targeting and the management of stranded assets.

Acknowledgements:

The authors would like to thank the Laudes Foundation and Partners for a New Economy for financial support. Thanks to Alex Barkawi and Olga Mikheeva for comments on earlier drafts. The paper also benefited from comments received from policy practitioners and academic participants in an online roundtable discussion held on 26 April 2022, hosted by the UCL Institute for Innovation and Public Purpose and the New Economics Foundation, entitled "Aligning Financial flows with the net-zero transition.”